Insight to a Maddening Employment Report

On the first Monday in September, the United States celebrates Labor Day -- a day meant to commemorate the social and economic achievements of American workers. For many Americans, it is simply seen as a ticket to a three-day weekend; and it is also seen as the unofficial end to summer.

The Friday before Labor Day, meanwhile, is seen by many as a chance to get a jump on the three-day weekend, such that it really becomes a three-and-a-half to four-day weekend.

Still, there is something very important to get to this week. It is the August employment report, which was disappointing relative to consensus estimates and at the same time maddening when considering its implications for the timing of the next rate hike from the Federal Reserve.

That's not "over-exaggerating" things either. It's the simple truth in a market that wants to believe the Fed won't raise rates this month, yet has to respect the outside possibility that the Fed will.

Elements of a Slowdown

First, let's get everyone acquainted with the notable headlines from the report and then a brief analysis will follow:

Nonfarm payrolls increased by 151,000 (Briefing.com consensus 180,000). Over the past three months, job gains have averaged 232,000 per month.

The U6 unemployment rate, which accounts for the total unemployed, plus all persons marginally attached to the workforce, plus total employed part-time for economic reasons, was unchanged at 9.7%

Persons unemployed for 27 weeks or more accounted for 26.1% of the unemployed versus 26.6% in July

August average hourly earnings were up 0.1% (Briefing.com consensus 0.2%) after being up 0.3% in July

Over the last 12 months, average hourly earnings have risen 2.4% versus 2.6% for the 12-month period ending in July

The average workweek was 34.3 hours (Briefing.com consensus 34.5) versus 34.4 hours in July

August manufacturing workweek was down 0.2 to 40.6 hours

Factory overtime was unchanged at 3.3 hours

The labor force participation rate was 62.8% versus 62.8% in July

In a nutshell, the pervasive message of the August employment report is that there was a deceleration in the labor market from recent months. The key elements in that respect were the slowdown in hiring, the drop in the average workweek, and the deceleration in average hourly earnings growth. The market picked up on this message in the immediate aftermath of the report's release and responded in a manner that suggested it didn't think the Fed will raise the fed funds rate in September. The evidence of that thinking manifested itself in several ways.

The probability of a rate hike at the September meeting, as seen in the fed funds futures market, dropped to 18% from 27% just prior to the report

Buying interest in the 2-yr note picked up

The U.S. Dollar Index rolled over; and

The S&P futures shot higher

All of that spoke to the notion that disappointing news is good news because it should mean the Fed won't raise interest rates. We really loathe that thinking, but alas, it is a distorted view borne out of the price distortions created by the Fed's seemingly incessant, monetary policy accommodation.

On Second Thought

Strikingly, the knee-jerk reactions to the employment report were slowly unwound. The probability of a rate hike in September moved back up to 27%; the 2-yr note gave back all of its gains, the U.S. Dollar Index reversed course and added to its recent gains, and the major stock indices pared a good chunk of their post-report gains.

Those swings exemplified a nagging notion that maybe, just maybe, the Fed will press ahead with a rate hike in September. After all, the employment report, which could have been better, still wasn't terrible.

Nonfarm payroll growth was above population growth and nonfarm payroll growth has still averaged 232,000 over the past three months. Also, market participants remained cognizant that research has shown that there are often large upward revisions to payrolls for the month of August.

For good measure, Richmond Fed President Lacker (not an FOMC voter this year) expressed his belief after the report was released that rates should be significantly higher than they are now. Mr. Lacker joins a growing pool of Fed officials prepping the market for the possibility that rates may go up sooner rather than later.

What It All Means

At one point on Friday, CNBC.com ran the following headlines (with one right above the other):

Jobs report misses, September rate hike 'off the table'

Watch out! The Fed could still hike rates in September

Kudos to the headline writer for doing his/her job. The headlines were so oppositional that I had to click on both to see what was actually written. The differences really boiled down to whom CNBC was talking and the views those pundits expressed after considering the report.

That is really the maddening aspect of the August report. It wasn't strong enough nor weak enough to provide any real closure on the matter of when the Fed will next raise the fed funds rate.

So, what do I think the Fed will do in September? I would say the Fed acquiesces to the predictive powers of the fed funds futures market once again and refrains from raising the fed funds rate.

What we know about this Fed is that it has been reluctant to pull the trigger on another rate hike because it is looking for certain and sustainable improvement in the employment and inflation data.

The totality of the August employment report left room for doubt on both counts and that just might lead the Fed to think it has enough wiggle room to avoid instituting a mostly unexpected rate hike in front of the election.

Patrick J. O’Hare, Briefing.com

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